Private Assetbased Reallocations An Introduction Andrew Mason University

Private Asset-based Reallocations: An Introduction Andrew Mason University of Hawaii and the East-West Center National Transfer Accounts 1

Outline ► Overview of Asset-based Reallocations ► Implementation with Illustrative Values ► Conclusions National Transfer Accounts 2

Asset-based Reallocations: Two Mechanisms ► Assets generate interage flows in two ways: ► Asset-income § Assets yields positive asset income, an inflow § Debt yields negative asset income, an outflow ► Saving § Acquiring an asset or disposing of debt, generates an outflows § Disposing of an asset or acquiring debt, generates an inflow. ► Asset-based reallocations are incorporated into NTA based on the flow constraint National Transfer Accounts 3

The Flow Account Identity ► Inflows § § § Labor Income Asset Income Transfer Inflows National Transfer Accounts ► Outflows § § § Consumption Saving Transfer Outflows 4

Forms of Assets and Asset Income ► Capital ► Financial assets § Yields capital income § Examples: Equipment, commercial structures, vehicles, inventories, homes. § All financial assets have a counterpart (counterpart of credit is debt, for example) § Yields property income § Outflow for one unit and inflow for another unit § For the economy (private, public and ROW combined) property income and each component must sum to zero. Examples of property income: Interest, dividends, land rent, and royalties. ► See UNSNA 1993 for a more complete and detailed discussion of assets and asset income ► National Transfer Accounts 5

Use of Asset-based Reallocations Features of assets limit their use: Children do not own assets as a general rule. ► Capital can only be used to reallocate resources from young ages to old ages. ► Because financial assets always have a counterpart, demand must be matched by supply. If one age group is a net debtor, for example, another age group, the government, or the ROW must be a net creditor. ► Constraints on indebtedness limit the use of debt for downward reallocations by young adults. ► National Transfer Accounts 6

Possible Uses of AR ► Lifecycle saving: accumulating assets during the working ages to support retirement. ► Saving to fund transfers § Saving to fund downward transfers (college saving plans) § Saving to fund transfers to elderly parents ► Bequest saving § Funding retirement using inheritances § Saving to generate bequests ► Other saving models may have incidental on interage flows National Transfer Accounts effects 7

Lifecycle Saving for Retirement Age 45 -64: Save labor income of $1000 per year plus all asset income. Age 65 -90: Dis-save a constant amount in each year. Saving Asset income Asset-based reallocations National Transfer Accounts 8

AR Patterns for Other Uses ► Saving to fund transfers § Saving by young adults § AR inflows to adults with costly children or elderly parents ► Bequest saving § Saving by working age adults § Limited dis-saving by older adults ► Reliance on inheritance § Limited saving by working age adults § Significant AR inflows at older ages (asset income from inherited assets). National Transfer Accounts 9

Complexities in Interpreting AR Patterns Age patterns reflect multiple objectives and influences ► Many theories describe lifetime behavior of a cohort; data are for a cross-section. ► Behavior of any age group reflects its history. Older age groups often have very different economic and demographic histories than younger age groups. ► Patterns may reflect important social changes (decline of extended family) or institutional change (emergence of financial markets). ► AR for any year may reflect important time effects, e. g. , a financial crisis or the implementation of a new policy. ► National Transfer Accounts 10

Implementation ► Definitions and Aggregate Controls (Relationship to UNSNA 1993) § Private sector § Asset income § Saving ► Constructing Age Profiles § Lifecycle model § Bequests and other capital transfers § Other models National Transfer Accounts 11

What does private mean? Private refers to all inflows to and outflows from the household sector, the corporate sector (financial and nonfinancial), and non-profit institutions serving households (NPISHs). ► Public enterprise is part of the private sector. ► § Operating surplus is private asset income § Dividends and other distributions by public enterprise to the government are part of public asset income ► Intersectoral flows between the private sector, the government and ROW are important § Public debt leads to private asset income (interest) § Foreign investment leads to flows between private and ROW National Transfer Accounts 12

Computing Asset Income Asset income consists of capital income and property income ► Capital income is the return to capital net of depreciation ► § Three components of capital income ► Operating surplus of corporations ► Capital’s share of mixed income ► Operating surplus of households (return to owner-occupied housing) and other consumer durables (if possible) § No exact counterpart in SNA because mixed income is not allocated between return to capital and return to labor § Capital income is the estimated value net of subsidies and taxes on production. National Transfer Accounts 13

Computing Asset Income (cont) ► Property income § Interest § Other property income ► Dividends and similar distributions ► Rent (returns to land, royalties on fossil fuels and other sub-soil minerals) ► Other less important components § Important check on property income: ► For the economy as a whole property income and each component (interest, dividends, rent, etc. ) must sum to zero. ► Private flows are non-zero and balanced by public flows or ROW flows. National Transfer Accounts 14

Aggregate Controls: Capital Income ► Operating surplus of corporations and NPISHs ► Capital’s share of mixed income ► Operating surplus of households (imputed rent of owner-occupied housing) ► Taxes on products and production; subsidies National Transfer Accounts 15

Sources of data and adjustments ► Source: NIPA § Operating surplus for each sector § Mixed income § Taxes on products and production § Subsidies ► Adjustments § Mixed income includes returns to labor; assume that 1/3 is a return is capital income § Taxes and subsidies ► Follow same procedures used elsewhere ► As a broad rule taxes on production net of subsidies are allocated between capital income and labor income in proportion to their relative income shares. National Transfer Accounts 16

Capital income in Taiwan An Illustration Capital Income and Components, Taiwan, 1998, NT$ Millions Capital income 2, 87 8, 4 5 1 Operating surplus, net 2, 60 5, 4 2 9 Operating surplus of National Transfer Aand ccounts corporations 1, 98 0, 1 0 17

Aggregate Controls: Property Income ► Property income is available in SNA by sector and type of property income ► Mapping of NIPA sectors NTA sectors § General government public § Households, NPISHs, corporations private § ROW ► Exact classification of property income varies, but for NTA important to know: § Interest, household and other separately § Other property income, i. e. , all property income other than interest combined. National Transfer Accounts 18

Property Income in Taiwan An Example Property Income and Components, Taiwan, 1998, NT$ Millions Property income, net Property income, inflows Property income, outflows Interest, net Inflows Outflows Other property income, net Inflows Outflows National Transfer Accounts Total Private ROW Public 0 -172, 192 -81, 097 253, 289 3, 883, 803 3, 361, 863 127, 902 394, 038 -3, 883, 803 -3, 534, 056 -208, 999 -140, 748 0 218, 625 -121, 713 -96, 912 2, 606, 230 2, 487, 285 75, 108 43, 837 -2, 606, 230 -2, 268, 661 -196, 821 -140, 748 0 -390, 817 40, 616 350, 201 1, 277, 573 874, 578 52, 794 350, 201 -1, 277, 573 -1, 265, 395 -12, 178 0 19

Intersectoral Flows ►A complete set of accounts requires data (or estimates) of intersectoral flows of property income. § Ex: Interest paid to ROW by the private sector. ► Some information is often available: § Interest paid by government to ROW. § Interest paid by the private sector on govt loans. ► Intersectoral flows can be approximated if direct estimates are not available. § AR spreadsheet calculates intersectoral flows by assuming that some flows are known and that other flows are proportional to totals. National Transfer Accounts 20

Intersectoral Flows of Interest An Example from Taiwan Intersectoral Flows of Interest, Taiwan, 1998, NT$ Million Inflows to: Outflows from: Public Private ROW Total - 140, 693 55 140, 748 39, 352 2, 154, 256 75, 053 2, 268, 661 ROW 4, 485 192, 336 - 196, 821 Total 43, 837 2, 487, 285 75, 108 2, 606, 230 Public Private Note: Outflows and inflows are both represented as positive values in this table. National Transfer Accounts 21

Private Saving ► NTA Saving is equivalent to private saving net of depreciation in SNA. ► Saving does not include some economic flows that affect the value of assets owned: § Capital transfers, e. g. , bequests, dowry, and other large gifts § Holding gains, e. g. , asset price changes, wars, and natural disasters ► A(t)= A(t-1) + S(t) + K transfers (t) + Holding gains (t) for any cohort National Transfer Accounts 22

Age Profiles for Asset-based Flows ► Difficult to assign asset-based flows to individuals § Assets are often jointly owned § Legal ownership and effective ownership may differ § Limited information from surveys ► In NTA saving and asset-income are assigned to the age of the household head National Transfer Accounts 23

Determining Age Profiles for Interest ► Interest from business credit § Many private credit transactions involve financial transactions between firms, e. g. , between financial and non-financial institutions. § Inter-age flows may not arise from these transactions. NTA assumes that they do not. ► Interest from consumer credit § Individuals borrow and lend to realize age reallocation objectives. § Role in age reallocations is limited because ► Children cannot be held liable for debts ► No natural private counterpart for funding accumulating credit during working years. National Transfer Accounts retirement by 24

Determining Age Profiles for Interest ► Interest payments between firms (corporations) do not generate net interage flows in NTA. § Age profile of inflows and outflows are identical. § Interest flows between firms and public sector or ROW does lead to net interage flows. ► Interest payments between consumers and firms do generate net interage flows. § Age profile of interest expense for consumers differs from the age profile of interest income for firms. § Consumer interest expense is approximated by interest outflows from households. National Transfer Accounts 25

Sources for NTA Age Profiles Profile from income and expenditure survey NTA Profile Property income (Interest, dividends, rental income) Operating surplus (except households), property income inflows, property income outflows (except consumer interest) Self-employment income, income from family business Mixed income (capital’s share) Imputed rent from owner-occupied Operating surplus housing Interest expense National Transfer Accounts Consumer Interest Outflow 26

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Calculation of AR Flows ► Per capita age profiles and population data are used to calculate the age distribution of each class of asset income. ► Age distributions are combined with aggregate values to calculate asset income by age. ► Saving by age is calculated as the residual, S(a)=T(a)+YA(a)-LCD(a); private saving is equal to total saving less public saving. ► Check: S(a) must total to net private saving. National Transfer Accounts 28

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Summary of Technical Problems ► Role of household head § Definitions vary across surveys ► Most surveys use an economic definition, e. g. , principal ► Some surveys use a self-reported head concept. earner. § Non-head members have asset-based flows that are assigned to the head § Estimates of asset-based mitigate these problems ► Assignment of operating surplus ► Estimates at upper ages may be unreliable due to small number of observations. § Household surveys include only the distributed earnings of corporations. § Methodology assumes that retained earnings has the same age profile as non-retained earnings. National Transfer Accounts 34

Issues to Explore with Asset-based Reallocations ► Do the elderly rely on assets to fund their retirement years? ► Is the importance of asset-based reallocations changing over time? If so, why? § Asset income § Dis-saving § Changes in public transfer policy? § Decline in the extended family? § Changes in financial systems, interest rates, etc. ? ► How are current generations of prime-age adults behaving? § Are their saving enough to meet their future retirement needs? § Are they accumulating too much debt to finance education, purchases of homes, and other consumer durables? National Transfer Accounts 35

Issues (continued) ► How important are bequests and other capital transfers relative to lifecycle saving? ► Do asset-based reallocations serve other important roles? Do people rely on assets to support their children, for example? ► How is population aging interacting with assetbased reallocations to influence important macroeconomic trends? ► How is the financial crisis affecting support systems and the economic circumstances of different generations? National Transfer Accounts 36

Conclusions ► Private issues. § § § asset-based reallocations bear on many Importance to solving lifecycle problems Implications for intergenerational equity Effects on macroeconomic performance ► Interpret with care § Difficult to measure § Outcomes reflect complex behavior and historical patterns that differ widely across cohorts National Transfer Accounts 37

Acknowledgement Support for this project has been provided by the following institutions: ► the John D. and Catherine T. Mac. Arthur Foundation; ► the National Institute on Aging: NIA, R 37 -AG 025488 and NIA, R 01 -AG 025247; ► the International Development Research Centre (IDRC); ► the United Nations Population Fund (UNFPA); ► the Academic Frontier Project for Private Universities: matching fund subsidy from MEXT (Ministry of Education, Culture, Sports, Science and Technology), 2006 -10, granted to the Nihon University Population Research Institute. National Transfer Accounts 38

The End National Transfer Accounts 39